Remarks Of
Isaac C. Hunt, Jr.
Commissioner*
U.S. Securities and Exchange Commission
Washington, D.C.
"Underwriting: The Year that Was, Trends, and Comments"
RIBA Mid-Atlantic States Capital Conference
Pentagon City, VA
April 18, 1997
_____________
* The views expressed herein are those of Commissioner Hunt
and do not necessarily represent those of the Commission,
other Commissioners or staff.
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Good afternoon. Thank you for inviting me to this year's
conference. I know that your organization is committed to
strengthening the capital formation process for emerging growth
companies. I also am aware that during the last three years,
RIBA-member firms managed or co-managed more than 500
underwritings. Those underwritings raised over five billion
dollars of new capital for a vital sector of the American economy.
That is something to be proud of, and I applaud your efforts.
The Year In Review. 1996, of course, was a terrific year for
underwriters as a whole, and not just in the market niche
dominated by your firms. According to a January article in
Investment Dealers' Digest, new issues raised 115 billion dollars in
the U.S. in 1996, 40% more than in 1995. Initial public offerings
accounted for 50 billion dollars of that total, which is an increase
of 66% from 1995.
The size of some of last year's IPOs was staggering: Lucent
Technologies three billion dollar deal was the largest domestic IPO
in history, and Deutsche Telekom AG's 11.3 billion dollar deal
was the largest foreign IPO in the United States.
These big deals were big news. In my view, however, the
two most significant items last year in the underwriting arena
were related to your sector of the marketplace: the emerging
growth sector. But before I offer begin that discussion, let me
make the disclaimer that the views I express today are my own,
and may not represent those of the SEC, my fellow
Commissioners, or the staff of the SEC.
Direct Public Offerings. First, 1996 saw even more small
companies launching their own IPOs on the Internet, what some
refer to as "direct public offerings." To the extent that those
offerings need to be registered with the SEC, they are subject to
our filing requirements and antifraud provisions but not to an
underwriter's scrutiny. And, to the extent that underwriters are
not there to provide scrutiny, the issuer, along with its directors
and accountants, are left to the task of disclosing any and all
material risks to investors.
Yet as was noted in the recent report of the Advisory
Committee on the Capital Formation and Regulatory Processes --
ably chaired by my fellow Commissioner, Steve Wallman -- many
believe that our Securities Act disclosure system is so successful
because of the effect of the Act's liability provisions on
underwriters and other "gatekeepers." Underwriters, of course,
scrutinize the company, its business and its management, and that
level of scrutiny is predicated largely on the exposure to liability
for false or misleading disclosures in the registration statement.
The use of direct public offerings likely will continue. The
Internet only will become more accessible to average Americans.
Further, let's look at the age group of Americans probably most
accustomed to "surfing the net" -- for this purpose, let me use the
more technologically agile set between the ages of 15 and 35. This
group soon will begin to make their own savings and investment
decisions, if they haven't done so already.
Market participants and the Commission should assume that
this generation of investors will be as comfortable making
investment decisions on the Web as my generation is over the
telephone. After all, Web-surfers race through the maze that is
the World Wide Web the same way that a bicycle messenger races
through city streets. Perhaps the only thing left to be decided for
these new investors is whether they will conduct their trades via
computer hook-ups with more traditional brokers, through
specially designed computer trading systems, or by directly
logging onto an issuer's Web site.
Without question, the Commission is compelled to respond to
this changing environment. We must regulate where appropriate,
but we must deregulate if that is the better course.
Yet this environment also means new pressures for you and
your firms. You may be asked by clients to use the Internet to
help sell all or part of an underwriting. You may have to provide
clients with services unrelated to traditional underwriting and
brokerage. And, there likely will be pressures on price.
Underwriting in a "Hot" Market. My second observation is
that 1996 saw remarkable interest by investors in new issuances,
whether they were large or small. The IDD article I referred to
earlier noted that with a few obvious exceptions -- such as the
failed IPO for Wired Ventures -- underwriters had it relatively
"easy" in 1996, especially in the first half of the year. The article
quoted a managing director and senior manager of a large firm's
equity group as saying that "mutual funds,especially emerging
growth funds, contributed greatly to new issues doing well."
Of course, I'll leave it to each of you whether you had an
easy 1996, and whether micro-cap fund managers were chomping
at the bit to get at your clients's stock. And, even if this were the
case in 1996, I certainly can't predict whether that will continue.
But this type of business environment raises its own unique
concerns. You may have seen the recent story in the Wall Street
Journal regarding Emanuel Pinez, the former CEO of Centennial
Technologies. He's in jail awaiting trial on securities fraud
charges. There also has been Commission action against him, and
I won't discuss that in any detail.
Pinez is charged with, among other things, padding
Centennial's books with phony sales. In the Wall Street Journal
article, a Centennial representative states that the alleged conduct
went undetected for three years by the company's managers as
well as by its board. Further, Centennial's auditor and four
brokerage firms helped the company raise 30 million dollars
during that time but, apparently, didn't detect any problems.
The article notes that "reports of improprieties and
untruthful, even outlandish, claims" followed Mr. Pinez wherever
he went in life. "In a less-hectic stock market," the article reports
lawyers and investment bankers as saying, "underwriters might
have done a thorough background search that could have raised
red flags and prevented the Centennial debacle."
In fact, a lawyer from a large law firm -- probably, one not
involved with Centennial -- is quoted in the article as saying that
underwriters have been so busy "that they often rely exclusively
on meetings with management for their information."
Now I don't know what happened with respect to the firms
discussed in the article. I am not making any judgments. But I
appreciate the article's point: that it may be hard for
underwriting firms to provide appropriate scrutiny in a market
such as this one, where: (1) issuers need quick money, (2)
underwriters need to move to the next deal, and (3) investors's
collective appetites seem insatiable.
I suggested earlier that there may be concerns where an
underwriter is not involved in a deal. But those same concerns
may be present if an underwriter's scrutiny is limited because of
the pressures of a "hot" market.
Perhaps I have sounded a little "gloom-and-doomish," but
please do not overestimate my concerns. I do not wake up at
night in fear of the next direct public offering, and nor should
investors. I know that issuers in those offerings and the
gatekeepers involved will try to do the right thing.
I also know that, day in and day out, underwriters do a
tremendous job for the markets and investors. After all, it's only
the failures that get reported in the press or end up on my desk as
enforcement recommendations.
Proposed Changes to Rule 430A. Still, I bring the concerns
I just expressed "to the table" when I consider SEC action that
might impact underwriting practices. And it is in this context
that I view the SEC's recent proposed revisions to Rule 430A
under the Securities Act.
Under current rules, a company that is not eligible to use
shelf registration faces restraints on timing its offering to meet
financing needs and market windows. It must coordinate the
effectiveness of its registration statement with the time that it
would like to offer and sell its securities. It then must price the
securities promptly after effectiveness, subject to the somewhat
limited flexibility afforded by Rule 430A.
In general, the SEC's proposed changes to Rule 430A would
allow smaller, less-seasoned issuers to delay the pricing of
securities offerings for a significant amount of time after
registration is declared effective. One commentator called the
proposal a "back-door primary shelf." The proposal would
provide increased flexibility for smaller issuers to take advantage
of market conditions. The changes also might reduce the need for
these issuers to rely on Regulation S and private placements.
In particular, an eligible company could delay pricing its
offering beyond the Rule's current 15-day period. It could omit
the same information from the prospectus before pricing as
currently, and omit the name of the managing underwriter. In
fact, the company could delay pricing and naming an underwriter
for a year after effectiveness. The company eventually would
provide the omitted information in a Rule 424(b) prospectus
supplement not subject to SEC staff review.
To be eligible, the company would comply with certain
limited conditions beyond those already in Rule 430A. Most
significantly, it would deliver a red herring to investors 48 hours
before sale (as currently is required for IPOs). The prospectus
would be accompanied by the company's latest 10-Q and current
8-Ks unless the supplement has that information. The issuer also
would have to be a reporting company for the last 12 months.
Curiously, the proposal would not require those reports to have
been timely during that period.
At the open SEC meeting on this proposal, I stated that I
had serious reservations. In general, my concerns are with the
possible consequences of the proposed changes on retail investors
who, along with micro-cap mutual funds, probably are the chief
purchasers of the securities touched by the rule. However, I
thought it appropriate for the SEC to propose the changes and
seek comments from the investment community and the public.
First, the proposal would permit significant "disaggregation"
of disclosure. By that, I mean it would allow an issuer to send to
a purchaser, with the confirm, the following: a prospectus
omitting the pricing information, a supplement, a 10-K, the most
recent 10-Q, and mandated 8-Ks.
That's a lot of disclosure, but I don't know that it is good
disclosure. On some level, the investor may not be able to use the
information to make an informed investment decision.
Perhaps more important to this audience, the quality of
disclosure delivered to investors may be reduced if the proposal
has a negative impact on the ability of underwriters to conduct
effective due diligence. Now, I don't know whether that will
occur, but it must be considered. The SEC's proposing release
discusses the possible impact of the rule on underwriting
practices, and asks a number of questions. I'll read you just a
portion of that discussion:
Under the current offering process for smaller companies,
ample time exists for these "gatekeepers" to carry out due
diligence activities. Concerns have been raised that the
expedited access to the markets that would be provided by
these proposals could make it difficult for gatekeepers,
particularly underwriters, to perform adequate due diligence
... This may be particularly true if a company is able to seek
aggressive competitive bids from several underwriters in a
very short time frame immediately before offering its
securities.
Unfortunately, time does not permit me to read the entire
discussion. I urge you to read it -- the release is available on our
Web site -- and let us know what you think. The one comment I
have seen is not from an underwriter; it states, and I quote, "a
reputable underwriter would not have sufficient time to perform
adequate due diligence" under the new proposals (end of quote).
I look forward to your comments on the proposal. While the
comment period expires April 29, just contact us if you need more
time to respond. I assure you that I will carefully consider your
comments -- whether they be pro or con.
Thank you for the opportunity to share my views with you.